Will the housing bubble burst hit India?

The sub-prime problem may not be a big deal in itself. But it’s a symptom of a bigger problem in the real economy: the bursting of the US housing bubble… The US is not the only market with a housing bubble: bigger bubbles can be seen in other countries, notably Britain. The main danger ahead is a serial bursting of housing bubbles across continents, affecting India too.

Last Sunday, I wrote that a financial tempest brewing in the US sub-prime mortgage market had a 33% chance of being a small problem, a 33% chance of becoming a serious problem that roiled markets and dented economies (but without damaging them), and a 33% chance of becoming a global recession that hit economies as well as markets. Stock markets fell further across the world last week, providing fuel for pessimists.

However, serious professionals whom I respect take a very different view. Jamal Mecklai, a top financial consultant, argues that even if losses in the US sub-prime mortgage market exceed $200 billion, this will be a drop in the massive ocean of global finance. Profits in the financial world have been gargantuan in recent years, and Wall Street traders got bonuses totalling $45 billion last year. Mecklai thinks some hedge funds will surely lose billions, but losses for some can become a profit opportunity for others who buy cheaply at distress sales. On balance, he views this as a small problem, not a serious or disastrous one.

T T Ram Mohan, Professor at IIM Ahmedabad, points out that stock market crashes do not automatically mean economic crashes. The great crash of 1929 is associated in the public mind with the Great Depression that followed, but in fact the latter was caused by multiple bank failures and self-destructive protectionist measures. Today, the fundamentals of the world economy look great, thanks to rising productivity and savings. These have created record global growth. The IMF forecasts continuing fast growth, viewing the US sub-prime problem as just a blip.

In the US itself, Treasury Secretary Paulson and Fed Chairman Bernanke have claimed that the sub-prime problem is a local issue that has been contained. However, both have looked rather silly as news comes day after day of the sub-prime virus infecting financial companies across the globe. Already affected are IKB Bank in Germany, Macquarie Bank in Australia, BNP-Paribas in France and NIBC Bank in Holland. Hedge funds run by institutions ranging from Bear Stearns to Goldman Sachs have taken a hit. In today’s world of finance, mortgages are chopped into bits, packaged with other mortgages, and then sold to investors across the world.

In this manner, a problem originating in the US has become global. But will it worsen into a disaster? Some hedge funds and investment funds may collapse, but optimists put a positive spin on this. They say that hedge funds and derivatives are the new shock absorbers of the world economy, absorbing shocks while letting the world economy carry on over major bumps. Replacing damaged shock absorbers is much cheaper than replacing entire vehicles.

There is something to be said for these views. Which is why I give a 33% chance of the current problem blowing over. I also agree that what matters for prosperity is the performance of economies, not stock markets, and a market crash need not translate into an economic crash. Global economic fundamentals are stronger than they have been for years. And central banks everywhere have provided ample additional funds to stock markets to scotch any possible liquidity crunch.

Yet, optimists suffer from a blind spot. The sub-prime problem may not be a big deal in itself. But it is a symptom of a much bigger problem in the real economy: the bursting of the US housing bubble. After rising stridently for years, even through the global recession of 2001, the US housing market has slumped. All the top house-construction companies are deep in the red. Housing and allied industries contribute almost 25% to the US economy, so a housing setback can quickly become an economic one.

Home-owners have for years gone on a spending spree, financed by loans against rising home prices. Now that house prices are falling, not rising, the spending spree will surely be affected. Reduced consumer spending plus the housing slump could send the US economy into recession by the end of this year.

The US is not the only market with a housing bubble: bigger bubbles can be seen in many other countries, notably Britain. The main danger ahead is a serial bursting of housing bubbles across continents, affecting India too. Jennifer Ryan of Bloomberg says that sub-prime problems in Britain may be worse than in the US. British foreclosures there have risen 3% in the first half of 2007, though from a low base.

The stock market slump has obliged mortgage lenders globally to switch from adventurism to extreme conservatism. So housing finance is suddenly drying up. This could further deepen the fall in house prices.

None of this is inevitable. As I said before, the world’s economic fundamentals are strong. High savings rates and productivity growth have produced a burst of sustained, rapid growth in both developing and developed countries. The global financial system has deep reserves that can withstand shocks. When I say there is a 33% chance of a global recession, I imply that it is not yet probable. But it is definitely possible.

One thought on “Will the housing bubble burst hit India?

  • 2013.Jan.13 at 13:08
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    Sir, Good article but you sound optimistic by saying that there is only a 33% chance of bubble bursting. The chances according to me is 200%. The credit system as we speak is collapsing. The same will happen to indian real esatate what happen to japan in 1989. Additionally, the euro is doomed and living on borrowed time. We are indeed living in some very exciting times and only those who are spiritually prepared will survive.

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